Cash Flow

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Counselors to America’s Small Business


Watching a business floundering, running out of cash even as it makes great sales
and profit advances, is painful. Painful though it may be, it is common and frequently the
cause of small business failure.

Our concern is how to identify, then avoid or control this problem. As times
change, as populations shift and other businesses start up and go out of business for
various reasons, as new competitors armed with new ideas and energy enter your market,
and as new products are developed and marketed with positive (or not so positive)
implications for your business - you have to do more than merely react! You must
understand these changes and then, when they occur be ready to respond or even turn
them to your own advantage. You have two ways to run your business: reactively or

A reactive management is always struggling to catch up with the latest outside
development. A reactive firm is at the mercy of its environment pushed about by forces it
cannot affect.

On the other hand, a proactive management anticipates problems, which may crop
up and plans ways to either turn them into opportunities to be exploited or blunt their
negative impact by forming strategies to handle them if they come to pass. This puts the
proactive management in control of the business, not the business in control, as is the
case with reactive management. The choice is either to control the situation or be
controlled by it.

Recognizing these choices, developing an understanding of different management
techniques is only part of the process. Needed also is a strategic context for both analysis
and action. This means understanding what you are going to do and why.

Small business survival calls for many functional skills -cash flow management is
one example -but underlying those skills must be the will to apply them. A proactive
management will use tools to shape its business's future, and will survive. A reactive
management won't "waste" the time planning cash flow unt il the crisis is already
overwhelming, and so will not survive.

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What is Cash Flow?

In its simplest form, cash flow refers to the flows of cash, literally, into and out of
the business. Think in terms of actual cash, dollar bills, flowing in and out of your
business, and then identify both their sources and uses to identify cash flow fluctuations
over an annual period

The sources of cash (inflows) are limited to:

§ New investment
§ New debt
§ Sale of fixed assets
§ Operating profits.

That’s it. There are no other sources. No hidden springs to be tapped in dry times.
Oh yes, about your fairy godmother – don’t count on her either. Inspecting this list will
show that each of these sources has important limitations on it as well. The only source
that can be depended on in an ongoing fashion is operating profits.

This is what makes profit planning such an important activity for any business. It
is only by profitable operation, and only when that profitable operation is accompanied
by a positive cash flow, that the business can grow.

The uses of cash (outflows) are as varied and as idiosyncratic as businesses and
business owners. The more obvious outflows are identified on the income statement as
expenses, except for such noncash items as depreciation. By definition, these noncash
items are not a part of your cash flow because they are an accounting process to prorate
the cost of equipment or other capital goods, which have already been purchased, and so
do not represent an actual use of cash in the present period. On the other hand, the total
purchase cost of a new piece of equipment would be a cash outflow even though only a
portion of that cost is transferred to the income statement as depreciation. Similarly,
another item to be added to the list of cash outflows is the principal portion of loan
payments, which, while not an expense, is still a use of cash.

The most useful way to conceptualize this process is to think of actual cash, dollar
bills, flowing in and out of the business, and then to identify its sources and uses. This is
cash-flow analysis.
Cash-flow analysis is described here as eight-step processes, which
will help you understand your own business better. For many users, this provides a
somewhat different view than they have had of their business previously. In addition to
improving profits, cash- flow analysis is particularly useful in helping to cope with
seasonal fluctuations and to avoid money crunches caused by rapid growth. The
underlying objective of the process is to make your business planning and operation more

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Why is cash flow so important? If the cash inflows exceed the cash outflows, your
business can continue operations. If the cash outflows exceed the inflows, your business
Runs Out Of Cash and grinds to a halt. Even if the imbalance is only for a short period, it
can spell disaster.

Cash management, controlling the cash flow, is vital to businesses of all sizes.
Small businesses are especially vulnerable to cash flow problems since they tend to
operate with inadequate cash reserves or none at all, and worse, tend to miss the
implications of a negative cash flow until it's too late.

Timing and cash flow are inseparable. Payments to your suppliers are typically
expected, often even before your customers pay you. As a result, you are likely to have a
negative cash flow when your business grows dramatically. Periods of change are always
reflected in an altered cash flow. If sales falloff, the cash flow slows down. Interestingly
enough, even if sales increase, the cash flo w may stop completely or even become
negative (more out than in). Think of the impact of credit sales on your cash flow, for
example. Such changes could be triggered by one-time events such as population shifts or
changes in competition. More commonly, seasonal fluctuations of your business may also
pose cash flow problems where a buildup of inventories must precede the sales cycle
(such as a toy business prior to the Christmas holidays).

Whatever the cause, the underlying message is simple: Run out of cash and you
are in trouble. Even if you can raise more money from other sources, sooner or later you
must match the timing of cash inflows and outflows if you are to remain in business.

How do you get your cash flow under control? It's not easy. Some businesses
never achieve cash flow control. These businesses are always in trouble, chronically
overdrawn, slow in paying bills, and will eventually fold. They fold though, only after
their owner/managers have spent a great deal of their time worrying and probably spent
all of their personal assets trying to cover the operating deficits. This kind of
complication need not be an integral part of business management. Instead Plan and
Schedule so that cash flow for your business is positive.

How To Manage Cash

The process of cash flow management does hot need to be mysterious or complex.
Cash flow management is all about timing inflows and outflows. Control will naturally
follow cash flow planning. The following eight-step process has been designed to show
the sequence of activities and how they can be applied in any business situation in order
to bring about a positive cash flow:

§ List cash inflows (sources).
§ List cash outflows (uses).
§ Identify when (by date) cash flows in or out.
§ Examine TIMING: cash inflows minus cash outflows.
§ Identify the major consequences of cash as it currently flows.
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§ Show constraints: inflows or outflows, which cannot be changed.
§ Identify inflows and outflows, which can be, changed -rescheduled.
§ Establish a plan for positive cash flow.

This process takes time and thought. Take time to experiment with combinations of
different alternatives. A controlled cash flow, the end result of this process, will more
than repay the time and effort you give to it. In fact, it may save the life of your business -
and your own future as well.

STEP 1: List Cash Inflows (Sources)

While new investment and new debt are sources of cash, they cannot be relied on
as permanent or repeat sources. Nor can the sale of fixed assets. These three sources are
not to be ignored, but they are secondary to operating profits.

Focus on operations as your main source of cash. Operating profit, unlike new
investment, debt, or sale of fixed assets, is ongoing. Since it is ongoing, it must be
constantly monitored, reviewed, and controlled.

Money flows into profitable businesses and away from unprofitable ones.
Although a stable operation which makes a profit will not usually have any cash flow
problems, any business which grows dramatically will. Growth, unless carefully
financed, can put a profitable business into bankruptcy even as the income statement
shows increasing profits. This represents a real tragedy. A business, which is growing and
making profits can suffer liquidity problems (the cash runs out), fail to meet its
obligations, and then be forced to shut down.

Why? Suppose you offer 45 day terms to your customers (or they take 45 - it
works out the same way) while you must pay your suppliers on the terms they offer, say
30 days, or even cash (COD). As sales grow, so will your receivables. Meanwhile you
continue your own payables on a current basis, and the gap between payables and
receivables gets wider and wider: a negative cash flow. Pretty soon you run out of cash.
Can this be prevented?

Timing and operations go together. For example, you may discover that a small
customer who pays promptly is more profitable for you than a large customer who pays
slowly. In fact, upon analysis, you may even determine that you can’t afford the larger
customer! (The payment uncertainty and resultant cash flow strain is an unacceptable risk
to your operation.)

Cash flow problems are frequently caused by collection problems. If you have
many chronic slow payers (which is endemic to some industries), either step up your
collection efforts, find some other way of jarring that cash loose (perhaps discounts), or
consider the possibilities of factoring or some other form of accounts receivable

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In any case, if you have one or more large slow-paying customers, analyze such
accounts. They may be costing you cash that you can’t afford. Even though it may seem
crazy, you may have to stop doing business with such a customer. The more these slow
payers purchase, the less you can afford to handle their orders.

Another problem that begins to sneak up on many businesses is that the period in
which their customers pay their bills begins to get longer and longer. This problem can be
identified in its development stages through an ongoing process of aging the receivables.
This will help you spot the slow paying and the super-slow paying customers. Aging
receivables is done by listing your accounts receivable in categories according to when
they were originally invoiced: 30,60,90,120, and more days. If you aren’t aware of slow
paying customers, you can’t very well improve your collection efforts.

Incidentally, successful collection efforts are often only a phone call or two away,
though sometimes letter of a more formal nature (sometimes from your attorney), or even
a small claims court appearance may be needed.

One of our clients, pushed into our arms by his bank, admitted that it was indeed
possible that his customers, Fortune 1000 companies, would pay their bills if asked to do
so – and on time. He then simply asked them to pay and they did. After that his fortunes
improved rapidly – so did his cash flow:

Another area of operations to examine closely is inventory. It is often wise to take
advantage of special bulk-rate offers, but it is also important to recognize that you may
end up buying problems. A bloated inventory will slow anyone’s cash flow down

At the same time, don’t ignore the opposite problem – trying to make a slim
inventory and too little capital work overtime. This is called overtrading and its usual
result is disaster. Overtrading is likely to result in stock outs, which will discourage and
perhaps lose customers and an inability to take advantage of volume discounts for
purchases or shipping. If just one customer fails to pay on time, the entire business blows

List you cash inflows, either by product or by customer (or both). This will help
you identify trouble spots, which hang up you cash flow and, in combination with an
aging of your receivables, will begin to focus your attention on timing of your cash flow.

STEP 2: List Cash Outflows (Uses)

Start with your cash journal and your checkbook. If you don't have either, you
shouldn't be in business. These are the heart of any cash control system.

Cash control failures are relatively rare (fidelity/theft) -though they do impact
your cash flow. More frequently, proper business practices are followed (which includes
cash control) but the small business still runs out of money. The first thing to determine is
Where is the cash going?
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This is a serious exercise. Every banker we've asked about this has agreed that
departing from the budget 'just this once" is a leading killer of small businesses, because
bending the budget rapidly becomes a habit. There are many variants: petty cash accounts
that amount to 50% of gross sales, salary increases which bear no relationship to
productivity and profits, a new Oriental carpet for the office, even long trips to buy
lunches in New York City (because big business tycoons lunch in New York?). The list is
endless. Put it all down. List Everything! Track down as many of the expenses as
possible and begin to ask: "Is this necessary or can we get along without it? Postpone it?
Is the timing OK? Would it make more sense to pay it earlier or later? Can it be done less

The answers here may save you some money immediately. We all tend to fall into
habits, which is certainly OK. Habits help us be efficient. But some habits are costly.
Paying bills as they come in is one habit that many small businesses fa ll into. Prompt
payment is fine, but if your customers are paying on a 45 day basis while you pay on a 5
day basis, your cash flow is being pinched unnecessarily -and your working capital
borrowing will compound the problem.

Timing is everything. Ideally, inflows are a bit faster than outflows. However,
over time, they must at least balance.

If you cannot determine where the cash is going, that’s the clearest possible sign
that you need better and more timely information. Ask you CPA for help. Your
accounting system contains the answers here. If you don’t have an accounting system,
you can’t determine what is happening – it’s just that simple.

Your accountant should help you design an accounting system that serves your
needs for information about your business. If your accountant isn't cooperative -doesn't
help you produce information in a timely manner and in a format that you can
understand, or doesn't answer your questions satisfactorily -get another accountant. These
professionals work for you and so must be responsive to your needs. Along with this
however are your responsibilities as well. It's your business and if you don't cooperate
with them; they can't do their jobs.

If You Can't Afford This Type Of Help You Shouldn't Be In Business!

STEP 3: Identify When (By Date) Cash Flows In Or Out

The most useful tool for this step of the process is a calendar. Get one large
enough to make notations in each date block, and begin to list -according to their timing -
the major cash inflows and outflows you have discovered in the first two steps. To be
most useful, one full business cycle should be displayed. For most businesses, especially
those with any son of cyclical variation, a year will be a useful period of time to be
examined, although monthly or perhaps even weekly periods may be relevant units of
time for inspection.
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Paydays, tax deposits, bank debt repayments and perhaps other obligations if
applicable. Begin listing these dates as you think of them. Keep listing over a period of
time because your list will not be complete the first few times you try this. You simply
won't think of everything.

We have occasionally suggested that this be done in a rough fashion with 3X5
cards. This allows you to begin shuffling the cards; quite literally, as yo u begin
examining the timing of these cash outflows and perhaps begin to realize that some of the
fixed payment dates are more flexible than they may first appear.

Once the payment dates, or cash outflow dates, are known, you can start putting
down cash inflows. This will result in a conservative cash flow if you allow for your
receivable experience and your seasonal or periodic sales fluctuations. Your aim is to
balance inflows and outflows to suit the peculiarities of your own business. If you can
achieve this, then you can grow with minimum interference from creditors and maximum
ability to take advantage of opportunities that may occur in your own business situation.

STEP 4: Examine Timing -Cash Inflows Minus Cash Outflows

A positive cash flow is one in which inflows are ahead of outflows. This must be
true not just as an average throughout the year, but consistently throughout the normal
business cycle. The reality is that any negative cash flow for any operating period must
be funded from some- where. That funding may come from a 90-day note or from the
normal operating cash balances, but it must be available. If it is not available, then the
business has a problem.

This is not to say that an occasional negative cash flow will spell trouble. There
are times when it makes more sense to adopt a negative cash flow temporarily (a growth
spurt for example). However, in order to survive, in the longer run your cash flow Must
be positive.

Most businesses have a rhythm. Farmers need time to grow their product, then
must wait for payment, then receive a lump of money which is used to payoff old debt,
make necessary improvements and purchases, and perhaps even to relax with. However,
during the same time that they have no cash inflows, they have substantial outflows. They
have the initial seasonal expenditures for seed, fertilizer, labor, and other such equipment
in March -at the beginning of their earning period, and typically at the end of a long non-
earning spell.

Earlier we mentioned the seasonal effe cts for a toy retailer. Inventories must be
built for the fall and Christmas selling season -on the heels of the summer quarter when
sales are typically lowest. Following the completion of a (hopefully great) Christmas, the
toy seller has converted inventories into cash, and so is able to pay for the essential
preseason inventory buildup.

Some of these payment clusters are unavoidable. Some may even be desirable.
But in the long run, it is the balance, the timing, which is critical.
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Assuming a positive cash flow (cash inflows exceed cash outflows) and assuming
that growth uses cash, you can grow at the rate that the inflows exceed the outflows. If
you attempt to grow at a rate faster than this, you will simply run out of cash. Growth
planning as well as survival planning needs to be a carefully structured process.

STEP 5: Identify The Major Consequences Of Cash As It Currently

Performing this step does not require numerical calculations so much as it
requires honesty about your actual operations. For many business managers, this may
become an unpleasant, surprising, or discouraging confrontation with reality.

The greatest problem small businesses have with cash flow stems from the human
tendency to believe that because you try to pay your bills on time, so does everyone else.
That's admirable, but dangerous. It is more reasonable to expect that your customers will
pay slowly. They have their own problems and other reasons for doing so.

It occurs to almost everyone in business eventually, that one way to improve cash
flow is to slow down the outflow while speeding up the inflow, particularly in a
tightening economy. The result is that payments are slow all the way around. Plan on it.

Subcontractors find this is a way of life, especially those who subcontract to
government contractors. It's a cost of doing business, which is not fatal unless it is
unanticipated. We've seen one small wholesaler who sold housing products to large
contractors more than double his profit by taking note of this fact. He arranged both trade
and bank credit around an anticipated 18 month payment cycle. As the major contractors
were on 12- month contracts, this worked out fine. They were paid in stages over 15
months and his receivables came in a month or so later than theirs. His credit improved
(because he paid off his obligations on a timely basis -and as agreed) and so he made
more money borrowing wisely.

Planning your cash flow is profitable. By looking at the timing of cash inflows
and out- flows, you will find ways to improve your profits by both cutting costs and by
increasing your opportunities. However, you can't plan unless you are aware of your
industry patterns as noted earlier.

Another major problem, particularly for small retailers, is cuff credit -the informal
credit businesses extend to their customers. Businesses frequently feel obliged to extend
credit when they actually cannot afford to tie up their working capital in this manner and
may in fact not need to provide this cuff service at all. Can you afford to extend credit -or
do you even have any choice? Many smaller retailers feel that they simply must.

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Ask your banker about bank credit card arrangements. Perhaps by taking the
standard discount you will speed up your cash flow and gain enough new customers (to
say nothing of avoiding collection problems) to more than offset the cost.

It is important to note also that costs of participating in these credit card plans are
often negotiable just as are interest rates of loans. Many smaller busine sses do not realize
this and quietly (and happily) accept whatever rate their friendly banker quotes to them. It
makes good sense to do some comparison-shopping for these "credit" purchases just as
you would do for any other item you have to buy for your business. After all, why should
you pay more than you have to?

Credit patterns take different forms. For example, consumer credit payments tend
to lag around Christmas and again around the summer vacation months, pick up briskly
in the spring as tax refunds come out, and pick up again in the fall. Can you handle that
kind of seasonal shift without being aware of it? Can you handle it even if you ARE
aware of it? Don't run the risk. Find out what the rhythms are -then use them.

STEP 6: Show Constraints: Inflows Or Out- Flows, Which Cannot Be

Not every payment can be rescheduled though (refer to Step 7), and not every
collection effort pays off. Your cash flow planning must respect these fixed constraints.

By identifying the most likely sticky places in the cash flow (both by analyzing
the past and by planning the future), you can prevent the real disasters of cash flow

You won't have much luck altering tax dates, and tinkering with payday is not
legal. Insurance payments tend to be rigid. After you have elected your schedule and have
missed a payment, your insurance may be cancelled.

Identify the apparently inflexible outflows. Some will be necessary, some may not
be. List them; plan around them. If they are really necessary and inflexible, you have no

With cash inflows the matter is different. While we can't always speed cash
inflows to our satisfaction, we can identify those customers who create snags and deal
with them on a one-by-one basis. Over time, this can significantly help your cash flow,
but it must be done consistently and selectively. We all have customers we cannot afford
to let buy our products. Even if they eventually pay up, think of the sales lost while they
tied up our cash.

A painful example of this was a service station owner who allowed his customers
to run up substantial cuff credit accounts, and then watched these customers, embarrassed
by their inability to pay off the account, go to his competitors and pay cash.

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Remember: cash flow management is timing inflows and outflows. A positive
cash flow is essential. A negative cash flow, over time, is fatal.

STEP 7: Identify Inflows And Outflows Which Can Be
Changed Or Rescheduled

At this stage, your major fixed cash flow points have been listed, your timing
examined, your rhythms explored, and your cash flow business habits carefully
scrutinized. Can any- thing be changed?

Sure. We often think that because something has been done on a certain schedule
in the past, that's how it must be. Nonsense. There's a lot to be said for Not paying bills
on the 1st and 15th.

We were asked to help a car dealer get his information together for a loan
proposal. He was caught in a cash squeeze caused by growth and needed an additional
$45,000 in working capital. His business was sound and could afford the debt. We
discovered as we analyzed his business that he really didn't need the loan. He paid his
bills, as they were received -a noble but unnecessary habit. The custom in the trade was
"net 30." We also noted that his purchases were averaging $45,000 per month. Our advice
-don't pay your bills for one month. He got his needed $45,000 in working capital and
saved his borrowing capacity for some other need. He also saved himself the annual
interest charges that the new debt would have incurred.

We don't suggest that you stop paying your bills, but we do suggest that you
analyze the process and make sure that you are taking advantage of such opportunities if
they are normal in your business.

There's merit in talking with your creditors and working out a payment schedule,
which fits your needs, not theirs. A surprising number of larger companies and banks are
happy to work out different payment arrangements. If they can help you prosper, they
prosper too. Take advantage of it!

Suppose your analysis has shown that in June and November you have extra cash,
while in March you're chronically short. Balloon payments help here. So will pre-planned
nonpayment months. Your larger creditors are interested in their own cash flow, but what
they most need is to know when they'll be paid. They have experts studying this problem.
Take advantage of their skills. If that March payment is going to be uncomfortably tight,
let them know well in advance, replan the schedule, and you'll both be better off for it.
You will also find that your relationship with these supplier/creditors improves

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